NCPA - National Center for Policy Analysis

Tax-Cutting Dynamics

May 16, 1996

If you have the imagination for it, suppose that Americans suddenly got a large tax cut. Would they alter their spending and saving habits? Certainly they would. That's just common sense.

But common sense has often been an uncommon commodity along the Potomac. And the way Congress and the Administration currently calculate future tax revenues is to assume no change in taxpayer habits. They calculate the effects in a "static" manner -- everyone continuing to act the same way they always did.

Some Republican congressional leaders want to reform the revenue estimation process by requiring the Joint Committee on Taxation and the Congressional Budget Office to take into account how taxpayers would react to hikes or cuts in taxes, by making calculations based on "dynamic" factors.

Tax rate cuts, for example, boost the economy and lure money out of tax shelters -- thus increasing government revenues.

The practice of making projections statically has led the JCT and the CBO into some major blunders in the past:

  • The 1990 luxury tax increase took in $14 million less than the $31 million the JCT forecast it would in fiscal year 1991.
  • Projections of the effect of 1986 tax changes -- which lowered income tax rates while increasing capital gains taxes -- erred by underestimating income tax revenues over the next three years by $56 billion and overestimating the five-year take from capital gains tax increases by $115 billion.

Private forecasters use dynamic methods already. One group forecast a five-year deficit of $1.045 trillion because of the 1990 tax hike. Official Washington guffawed. It was twice the government's forecast. But just six months later the Bush administration had to boost its forecast to within $6 million of the private estimate.

The present static scoring system inflates the apparent cost of tax cuts as well as the seeming benefit of tax hikes in terms of government revenues, according to tax specialists. This makes it harder for congress to justify tax cuts and easier for them to raise taxes. So cash is diverted from the private sector of the economy to government -- slowing the economy and killing job growth.

Source: Editorial, "Fiscal Prejudice," Investor's Business Daily, May 16, 1996.


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